The Joint Committee of the European Supervisory Authorities (or ESAs) have published an Opinion on the use of innovative solutions by banks and other financial services businesses when carrying out customer due diligence (CDD), (i.e. “know your customer”) in relation to customers and the prevention of money laundering and terrorist financing risks. The Opinion is aimed at national supervisors, but it is also essential reading for credit institutions (i.e. banks), as well as MiFID investment firms, funds, insurers and a range of other firms that are defined as “financial institutions” under the 4th Anti-Money Laundering Directive. The ESAs’ supervisory expectations may also be of interest to those providers of online or other innovative CDD solutions.
The Opinion’s content is “technology agnostic” i.e., it does not say what constitutes “good” or “bad” types of “innovative” or other online CDD solutions. Rather, the ESAs’ supervisory goals in this is Opinion is for firms to take note of the range of risks that are specific to online CDD solutions, their providers and how to embed measures to identify, mitigate and manage those risks and how to evidence compliance.
The Opinion identifies additional challenges to those inherent in CDD processes where firms move away from traditional face-to-face interactions to non-face-to-face online channels (i.e. where the customer is not physically present).
It is not yet clear how national supervisors will embed this Opinion in the day to day conduct of their business supervisory mandates. Firms should, however, consider updating their financial crime prevention policies notably in respect of anti-money laundering and combatting the financing of terrorism (AML/CFT) and their contracts with online CDD providers.
Key takeaways from Opinion
As a result of the Opinion, firms should be aware of certain supervisory standards and expectations in respect of their CDD. These include the following key takeaways:
- The ESAs recognise the benefit of online CDD for firms in digitising their operations but also note that that they should be mindful of how digitisation can impact their risk exposure to money laundering and terrorist financing. We would suggest that appropriate references be made in AML/CFT policies on how risks arising from online CDD (or other potential vulnerabilities to financial crime) are identified, mitigated and managed;
- The Opinion reiterates the existing general duties in the EU (which sets common minimum standards) and in national law to prevent financial crime such as the duty to investigate/verify the identity of a customer, the purpose and intended nature of the business relationship and the obligation to monitor the business relationships and transactions on an ongoing basis, as well as the duty to verify the accuracy of information accompanying fund transfers on the basis of data, documentation or information from “reliable and independent sources”;
- The Opinion confirms that EU law does not specify what constitutes “reliable and independent sources,” firms have – to the extent permitted by national law – some flexibility over what sources of information they use to meet CDD obligations and how these correspond to what is considered at law and from other non-legislative sources to constitute “good practice”. In light of the Opinion, firms should consider whether they need to review their current practices;
- The Opinion affirms that remote verification of customers’ identity, based on assessing traditional identity documents and the remote verification of identity in central identity documentation databases (see paras. 13 and 14) can be advantageous if it is supported by human decision-making/verification and appropriate demonstrable “understanding and ownership” of these processes by senior management. In that regard reference is made to:
- the importance of escalating “high-risk” customer types and Politically Exposed Persons (PEPs);
- the need to have in place an appropriate fallback to human channels (see para. 16) in the case of system failure or the suspension/termination of online CDD services by an external provider. This could mean that firms have to evidence that:
- staff have received appropriate training and have technical skills to oversee the development and proper implementation of online CDD, particularly where reliance is placed on external providers; and
- senior management and the compliance officer have an appropriate understanding of the online CDD processes;
- they have in place contingency plans which will also have to be documented, but more importantly should be addressed in the firm’s appropriate policies and contracts
- The Opinion clarifies that specific online CDD risks and a firm’s exposure to risks arising from their CDD solutions and providers must be considered and addressed in the firm’s risk assessments prior to deployment. This is consistent with general obligations on using outsourced service providers, as it evidences, notwithstanding an outsourced solution, that a firm maintains sufficient oversight and control as well as decision-making powers in relation to CDD as a whole, plus any changes to the online CDD process, especially those driven by service providers;
- The Opinion then sets out that firms are expected to confirm to the supervisors that they have in place sufficient safeguards regarding online CDD solutions to prevent breaches of data protection and other relevant legislation. Again, firms should ensure for this to be evidenced in accordance with EU outsourcing rules;
- The Opinion also addresses geographical risks (paras. 21 and 22) and (helpfully) points to the fact that firms can use device fingerprinting or geolocation (on mobile devices) to assess whether a customer is located in a jurisdiction associated with higher money laundering and terrorist financing risks; and
- Finally, the Opinion’s supervisory standards/expectations on “Reliability of CDD Measures” (para. 19) is consistent with existing communication by national supervisors. However, the way that these expectations are worded in the Opinion may require some firms to reconsider their approach as to how they document compliance.
In summary, the Opinion introduces clear-cut supervisory expectations on the national supervisors and equally the breadth of firms they supervise. The majority of these expectations might require firms to take remedial as well as new action with regard to their policies procedures and contracts. For a number of firms, the degree of the Opinion’s impact on how it approaches CDD will vary. That degree will depend not only on what types of “innovative solutions” it uses but how those solutions are embedded in the firms’ operations as well as how resilient they are to specific risks inherent in the solution as well as those inherent to the firm’s operations and its risk exposure.
Certain firm types may find compliance more difficult than others. For national supervisors, the ESAs expect them to work together to learn from one another and to build upon specialist online CDD training that the ESAs plan to offer. Whilst the Opinion does not shed light on what type of training the ESAs plan to offer national supervisors, the last sentence in paragraph 25 (third bullet point) is unequivocally brusque in stating: “…the ESAs consider the lack of understanding on behalf of competent authorities not to be a sufficient reason for preventing innovations and technologies from being used by firms to meet their AML/CFT [Financial Crime prevention] obligations.”
For those firms that are planning on, or those that already are, using online CDD or other innovative solutions as part of their general digitisation strategies, this general outlook on upskilling supervisory approaches may be quite welcome. These statements are also likely to be of interest to a range of solution providers as they compete in establishing their regulatory compliance capabilities. As financial services intermediation and interfaces with consumers transition to increased digitisation this will be an exciting area of compliance expectations and one of opportunity for a breadth of market participants and business models.